Author Topic: Should Repurchases be counted in FCF/yield per share?  (Read 17394 times)

Hielko

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Re: Should Repurchases be counted in FCF/yield per share?
« Reply #20 on: October 08, 2013, 05:17:18 PM »
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I stated that if you were to do it on a per-share basis
I'd say that this is the key element in the discussion. Yes, you can generate your own dividend by selling some percentage of your shares: but in that case you aren't talking about numbers on a per-share basis anymore since you are continually selling fractions of that share (in theory).


Palantir

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Re: Should Repurchases be counted in FCF/yield per share?
« Reply #21 on: October 08, 2013, 05:30:42 PM »
^Not talking about creating your own dividend, but the concept that you're essentially buying others shares with your FCF, which will reduce cash flow in current term, but raise it later.
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mcliu

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Re: Should Repurchases be counted in FCF/yield per share?
« Reply #22 on: October 08, 2013, 05:48:20 PM »
I'm not suggesting that share buybacks do not add value, but rather how to account for those buybacks?

Say you're investing in a company that makes 1M in FCF yearly, and zero growth. As a shareholder, you have a claim on 1M every year, and this is your "Free Cash Flow". However, if the firm allocates 30% of that to buybacks every year, then you are exchanging current flows for higher flows in the future, and as a result, it would be double counting to consider initial Free cash flow to equal 1M, rather it should be 700k, and in exchange for that you can build FCF growth into your model.

That makes sense.

ERICOPOLY

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Re: Should Repurchases be counted in FCF/yield per share?
« Reply #23 on: October 08, 2013, 06:28:37 PM »
However, if the firm allocates 30% of that to buybacks every year, then you are exchanging current flows for higher flows in the future, and as a result, it would be double counting to consider initial Free cash flow to equal 1M, rather it should be 700k, and in exchange for that you can build FCF growth into your model.

That gets a little weird if the firm were to stop buying back shares.  You are going to have free cash flow jump from 700k to 1m in a single year, even though FCF isn't growing.  That might sound like I'm bickering over semantics, but if I was collaborating with you on a software project I would mention that your choice of naming for variables makes the code difficult for others to understand/maintain. 

It might compile and run just fine though, no argument there.

Let me ask you a question though.  How would you go about it if you were instead looking at a company that returned cash to shareholders only through dividends.  Would you ignore the dividend yield, or would you instead count the dividend and redefine "free cash flow"?

Maybe there is another way without redefining what free cash flow is -- that's all I'm trying to say.  I'm not saying that your end result would be wrong.

LC

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Re: Should Repurchases be counted in FCF/yield per share?
« Reply #24 on: October 08, 2013, 07:19:00 PM »
I'll throw my hat in the ring:

I ignore buybacks in "modelling".

I just calculate FCF or Owner Earnings or whatever you want to call it.

What the company does with that cash afterwards I treat as a different story.

So I separate the analysis into two sections: what the business operations generate, and what management does with those proceeds afterwards.
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Carvel46

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Re: Should Repurchases be counted in FCF/yield per share?
« Reply #25 on: October 08, 2013, 07:43:22 PM »
Palantir,

In your example, you are not properly distinguishing between FCF and FCF/share.

After a stock buyback each share outstanding (not held in treasury), now has a larger % claim on the FCF. If it's a 30% buyback, FCF does NOT grow (now or in the future, based on the buyback)! FCF/share does grow!!

Try rewriting your example.
« Last Edit: October 08, 2013, 07:45:58 PM by Carvel46 »

Palantir

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Re: Should Repurchases be counted in FCF/yield per share?
« Reply #26 on: October 08, 2013, 08:54:34 PM »
That gets a little weird if the firm were to stop buying back shares.  You are going to have free cash flow jump from 700k to 1m in a single year, even though FCF isn't growing.  That might sound like I'm bickering over semantics, but if I was collaborating with you on a software project I would mention that your choice of naming for variables makes the code difficult for others to understand/maintain. 

It might compile and run just fine though, no argument there.

Let me ask you a question though.  How would you go about it if you were instead looking at a company that returned cash to shareholders only through dividends.  Would you ignore the dividend yield, or would you instead count the dividend and redefine "free cash flow"?

Maybe there is another way without redefining what free cash flow is -- that's all I'm trying to say.  I'm not saying that your end result would be wrong.

True, I am being lazy with the definitions. I would say the relevant metric for DCFs should be "Adjusted FCF" = FCF - Buybacks.

In your scenario, if the firm suddenly stops buying back, then Adjusted FCF = FCF, and then growth becomes 0, which essentially is the pre-buyback state, although now with higher FCF/s due to the buybacks.

Now if the firm returned all its FCF to shareholders via dividends, and assuming that no other cash was returned, then in that case, I would not revise the FCF figure downwards, as all FCF immediately flows to shareholders, and more importantly that cash is not reinvested to create growth in FCF/share. Therefore Adj. FCF = FCF, and growth is unchanged.
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hyten1

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Re: Should Repurchases be counted in FCF/yield per share?
« Reply #27 on: October 08, 2013, 09:44:22 PM »
Palantir,

i am a little confused, are you guys just looking at FCF/s in isolation? meaning at one point a company as $1  FCF/s and this company use the FCF to buy back share now suddenly its $1.2 FCF/s (since the number of share count has gone down for argument sake by 20%).

if you just look at FCF/s in isolation, you will be mislead in thinking there is 20% growth in FCF/s, but in reality there isn't (well there is depends on how you look at it, you now own more of the company, but the total FCF hasn't grown)

what exactly is the problem? i don't think you can just look at FCF/s in isolation without taking into account what is going on within the firm, if you are then there will be problems, just like any metric you look at in isolation, even the trusty PE ratio.

using FCF as sole metric in isolation can also mislead (this thread is a good example).


also look at the other way, what if company issue more shares and FCF stay the same, obviously same problem.

just my 2 cents

hy

That gets a little weird if the firm were to stop buying back shares.  You are going to have free cash flow jump from 700k to 1m in a single year, even though FCF isn't growing.  That might sound like I'm bickering over semantics, but if I was collaborating with you on a software project I would mention that your choice of naming for variables makes the code difficult for others to understand/maintain. 

It might compile and run just fine though, no argument there.

Let me ask you a question though.  How would you go about it if you were instead looking at a company that returned cash to shareholders only through dividends.  Would you ignore the dividend yield, or would you instead count the dividend and redefine "free cash flow"?

Maybe there is another way without redefining what free cash flow is -- that's all I'm trying to say.  I'm not saying that your end result would be wrong.

True, I am being lazy with the definitions. I would say the relevant metric for DCFs should be "Adjusted FCF" = FCF - Buybacks.

In your scenario, if the firm suddenly stops buying back, then Adjusted FCF = FCF, and then growth becomes 0, which essentially is the pre-buyback state, although now with higher FCF/s due to the buybacks.

Now if the firm returned all its FCF to shareholders via dividends, and assuming that no other cash was returned, then in that case, I would not revise the FCF figure downwards, as all FCF immediately flows to shareholders, and more importantly that cash is not reinvested to create growth in FCF/share. Therefore Adj. FCF = FCF, and growth is unchanged.
« Last Edit: October 08, 2013, 09:48:54 PM by hyten1 »

Rabbitisrich

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Re: Should Repurchases be counted in FCF/yield per share?
« Reply #28 on: October 08, 2013, 10:10:29 PM »
Discounted cash flows are generally a measure of business values. When you start looking at per share DCF, you are mixing up business results with your actions as an investor. A shareholder may choose to hold during a buyback, or choose to sell. Similarly, a dividend recipient may decide to reinvest, or not. That is not right or wrong, but such choices result from expectations that should already be included in your discount rates.

You stumble across a company that yields FCFE, pre-buyback, equal to your discount rate. But they announce that 100% of FCFE will go towards repurchasing shares. Management has not suddenly caused DCF to plummet to 0. Every moment your percentage ownership increases is another moment that you have reinvested in the firm. The growth rate of FCFE is unchanged. Your FCFE per share increases because of your reinvestment choices, just as if the firm changed course and announced a 100% dividend option. The same logic that compelled you to maintain shares in a buyback program, would cause you to purchase shares in a dividend program.
« Last Edit: October 08, 2013, 10:35:05 PM by Rabbitisrich »

Kiltacular

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Re: Should Repurchases be counted in FCF/yield per share?
« Reply #29 on: October 09, 2013, 12:38:31 AM »
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In the thread on Accenture PLC, one member stated a valuation method where the expected return on investment in a share = FCF Yield + Growth

I reposted the original basis for this discussion (which was amended later to add a "per share" idea, IIRC and spawned the rest of the thread). 

Just looking at the original, I think it is useful.  If the business can grow without using the free cash flow to do it (assuming cap-ex = depreciation), you've got a home run (if purchasing a good business / good price).  These businesses are typically light on tangible investment.  If you can get "growth" from the existing business without the needing to reinvest the true, free cash flow, you've got a winning business.  If you pay the free cash flow out, it is a dividend.  You still get the "growth" over the original share base -- together, the FCF as a dividend plus the growth will give you the return from the business.  If you decide to take the free cash flow and use it to reduce the share count that is also a return like a dividend (as Eric and Rabbit explained).  I think where the confusion is arriving is the idea that some portion of the "next year's" growth in per share profits is coming from reducing the sharecount rather than just the "growth" of the business w/out any FCF going anywhere but to the shareholder's pocket.  It is better to separate out of the repurchase so that you can see whether the business is growing without it -- such that the FCF is really FCF and growth is really growth (not just growth in per share profits because all the FCF was used to reduce shares). .

In any case, using FCF is the same (taxes aside) whether it is used for dividends or share buybacks.  The comparative value of each changes depending on the price paid for the buyback, as others discussed.  But, as long as they aren't the sole "source" of growth, then the original "equation" -- FCF + Growth -- still makes sense for total return.